Pension systems

Trimming pensions

More about public finances

Edward Whitehouse, Directorate for Employment, Labour and Social Affairs

Pensions are a major component of public expenditure, and a target for governments looking to streamline budgets. What are countries doing to manage costs at a time when populations are ageing at an accelerated pace?

It is unsurprising that pensions have been part of many governments' attempts to balance their books. Old-age and survivors' pensions are often the largest single item in budgets: public pension spending averages about 8% of GDP in OECD countries, or 16% of total government expenditure.

Pension spending faces upward pressure from the well known phenomenon of population ageing. There are currently around four people of working age (20-64) for every one of pensionable age (65+) in OECD countries. This ratio will fall to three in about 2025 and two in 2050. While all OECD countries are ageing, some countries are facing a greater demographic challenge than others. Japan, the demographically oldest, will have just 1.2 people of working age for every one of pension age in 2050, while Turkey will have more than three. The International Monetary Fund has calculated that the fiscal cost of ageing in the next 20 years will be nearly 10 times as large as the impact that the current crisis had on the public finances of the advanced G20 countries.

Many countries have already taken action to curtail future pension costs. The most visible change has been higher pensionable ages. From a low point of 62.5 years for men and 61.1 for women, the average pension age in OECD countries will increase to nearly 65 for both sexes in 2050. By that point, a number of OECD countries will have pension ages above 65 on current plans: 67 in Australia, Denmark, Germany, Iceland, Norway, the United States and 68 in the United Kingdom. Moving pension ages beyond 65 is also under serious consideration in Ireland and the Netherlands.

Financial sustainability remains an issue in many countries, with pension expenditures in seven countries projected in 2050 to exceed the highest figure today of 14% of GDP in Italy. This group includes Belgium, Italy, Luxembourg, Slovenia and Spain. France and Greece are also included, but these projections were made before their most recent pension reforms, which, in particular, make early retirement more difficult. Even in countries with relatively low public pension spending, such as Ireland and the United Kingdom, there have been moves to cut the costs of benefits for civil servants and other public-sector workers.

In other cases, the adequacy of benefits is an issue. Benefit cuts to make future pension costs more affordable may put older people at risk of poverty in the future. This is particularly the case in countries such as the Slovak Republic and Poland, where pension reforms significantly weakened the redistributive parts of retirement-income systems. It also holds in countries such as Germany and Japan, which have cut benefits across the board: the same proportional reduction for both low and high earners. In contrast, Finland, France and Sweden have protected low earners from the full force of cuts in benefits and maintained or improved old-age safety-net benefits. Australia and the UK have increased both pension ages and entitlements, with increased benefits targeting low-income pensioners.

Many countries have tried to encourage people to take out voluntary private pensions to complement meagre public retirement-income provisions for today's workers. Germany introduced a new type of private scheme with generous fiscal incentives: around two-thirds of the workforce joined. New Zealand's KiwiSaver is the first national scheme to use “automatic enrolment” of members. Workers have to actively opt out or else they are covered by the scheme; this expanded private-pension coverage includes from around 10% to 50% of the workforce. The UK will introduce similar arrangements in 2012; that will be the most important event of the year, ahead even of the Olympics, according to the former pensions minister earlier this year. Ireland has announced plans to follow suit.

The received wisdom has always been that reform is easier in times of plenty, when there are resources to compensate some of the losers. However, the contrasting mantra-“never waste a good crisis”-appears to have dominated pension policy in OECD countries. Since 2008, the pension reform process has, if anything, accelerated with many countries announcing major changes to retirement-income provision. But striking the right balance between benefit adequacy and fiscal sustainability remains a challenge.